‘Carbon bubble’ could spark global financial crisis

A team of international researchers warn that technological change in energy efficiency and renewable power could cause a sudden drop in demand for fossil fuels – wiping trillions from the global economy and sparking a global financial crisis.

Divesting from fossil fuels could help lessen the effects of a ‘carbon bubble’ and prevent a global financial crisis. (Image credit: kris krüg via Flickr)

Fossil fuel stocks have long been a safe financial bet. With price rises projected until 2040 and governments prevaricating or rowing back on the Paris Agreement, investor confidence is set to remain high.

Dramatic decline in fossil fuel demand

However, new research suggests that the momentum behind technological change in the global power and transportation sectors will lead to a dramatic decline in demand for fossil fuels in the near future.

The study indicates that this will now happen regardless of apparent market certainty or the adoption of climate policies – or lack thereof – by major nations.

Detailed simulations produced by an international team of economists and policy experts show this fall in demand has the potential to leave vast reserves of fossil fuels as “stranded assets”: abruptly shifting from high to low value sometime before 2035.

Huge ‘carbon bubble’

Such a sharp slump in fossil fuel price could cause a huge ‘carbon bubble’ built on long-term investments to burst. According to the study, the equivalent of between one and four trillion U.S. dollars could be wiped off the global economy in fossil fuel assets alone. A loss of $0.25 trillion triggered the crash of 2008 by comparison.

Publishing their findings last week in the journal Nature Climate Change, researchers from Cambridge University, Radboud University, the Open University, Macau University, and Cambridge Econometrics, argue that there will be clear economic winners and losers as a consequence.

Major carbon exporters set to lose

Japan, China and many EU nations currently rely on high-cost fossil fuel imports to meet energy needs. They could see national expenditure fall and – with the right investment in low-carbon technologies – a boost to Gross Domestic Product as well as increased employment in sustainable industries.

However, major carbon exporters with relatively high production costs, such as Canada, the United States and Russia, would see domestic fossil fuel industries collapse. Researchers warn that losses will only be exacerbated if incumbent governments continue to neglect renewable energy in favour of carbon-intensive economies.

Countries cannot ignore Paris Agreement

“Our analysis suggests that, contrary to investor expectations, the stranding of fossil fuels assets may happen even without new climate policies. This suggests a carbon bubble is forming and it is likely to burst,” said Jorge Viñuales, study co-author from Cambridge University’s Centre for Environment, Energy and Natural Resource Governance (C-EENRG).

“Individual nations cannot avoid the situation by ignoring the Paris Agreement or burying their heads in coal and tar sands,” he said. “For too long, global climate policy has been seen as a prisoner’s dilemma game, where some nations can do nothing and get a ‘free ride’ on the efforts of others. Our results show this is no longer the case.”

Move promptly but cautiously

However, one of the most alarming economic possibilities suggested by the study comes with a sudden push for climate policies – a 2C-target scenario – combined with declines in fossil fuel demand but continued levels of production. This could see an initial $4 trillion of fossil fuel assets vanish off the balance sheets.

“If we are to defuse this time-bomb in the global economy, we need to move promptly but cautiously,” said Hector Pollitt, study co-author from Cambridge Econometrics and C-EENRG. “The carbon bubble must be deflated before it becomes too big, but progress must also be carefully managed.”

Divest from fossil fuels

The authors argue that initial actions should include the diversifying of energy supplies as well as investment portfolios. “Divestment from fossil fuels is both a prudential and necessary thing to do,” said François Mercure, study lead author from C-EENRG and Radboud University. “Investment and pension funds need to evaluate how much of their money is in fossil fuel assets and reassess the risk they are taking.”

“A useful step would be to expand financial disclosure requirements, making companies and financial managers reveal assets at risk from fossil fuel decline, so that it becomes reflected in asset prices,” Mercure added.

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